The structure of the US consumer economy has been the key reason the country has avoided a significant economic downturn, despite the sharp rise in interest rates, according to Zurich's chief market strategist and head of macroeconomics .
Guy Miller said: “It is very unusual to get interest rates rising by 525 basis points [5.25 per cent] without an accident happening in the economy. This is especially true because the US is very exposed to the the consumer, around 70 per cent of GDP is consumption based. So I am surprised how resilient the US consumer has been, there have been interest rate hikes but nothing seems to have happened.”
He says the key to understanding this resilience is that both consumers and corporate entities in the US were able to lock-in very low interest rates on their mortgages and corporate debt, and so have been “immune” from rate rises.
Miller said: “Even though some of the repayment costs have risen, as a share of income they have only really gone back to 2019 levels. At the same time, wage growth has been there, household earnings have risen in nominal terms.”
He believes there have been unusual side-effects to this situation: “The cheap fixed rate mortgages people have, those are tied to the property, not to the individual, so no one wants to move house, no one can afford to really, because if they do, then they would have to pay much higher interest on a new mortgage. So the housing market has ground almost to a halt. And in the corporate world, they termed out their loans as far as they could. The corporate bond market this summer, had very little issuance. I mean the summer is always quiet for bond issuance, but this summer was exceptionally quiet.”
His view is that consumers and companies are keeping their powder dry for now in anticipation that rates will be cut in the coming months, making it cheaper to either refinance existing debt or take on new debt.
If rates are cut within that timeframe, it may lead to a “soft landing” for the US economy, whereby inflation falls to normal levels without a recession.
But Miller is sceptical this will happen. He says investors should look at emerging market economies, such as Brazil, which raised rates around a year prior to the US and then, after rates peaked, waited another year before cutting.
He believes the timeframe in the US will be shorter as growth falters, but the risk is that rates stay higher for longer than is presently expected by the market and many consumers.
In such a scenario, he compares the US economy to the cartoon character Wile E Coyote, who frequently runs off a cliff, but doesn’t fall immediately.
Miller compares the present situation in the US, whereby consumers and companies continue to pay down debt at rates which reflect history, rather than the current reality.
He feels that as soon as companies and households have to refinance, the higher interest rates they face will likely push the country into recession, though he doesn’t think it will be as severe as the most recent recessions to impact the country.
